Looking for Evil on an Income Statement

Here we are again, quarterly earnings season. And here we are again with people who have no clue how to read even the most basic income statement or P&L spouting off on the evils of corporations – especially those supposedly obscene "profits." Funny how profits depend on your perspective.

I thought I'd create a simple lesson with the following table. I've left off the company names and whether the dollar values are in thousands, millions, or (gasp!) billions – although I'll reveal them later (don't peek!). Let's look for some evil. Or 'eeeeevil' if you're a fan of Austin Powers.

Latest Quarter

A

E

F

G

H

W

Sales

25

114

567

38

7.7

79

Op Income

7.9

44

129

11

1.0

13

Taxes

1.9

8.0

17

3.9

0.2

4.0

Profit

6.0

11

116

3.4

0.3

2.6

Eff. Tax Rate

24%

42%

13%

34%

17%

32%

Profit Margin

24%

9%

20%

8%

4%

3%

So… here we go. Let's start with effective tax rate – boy company F must really be evil since they only pay 13%! How dare they! And company E must be one of the most patriotic and honorable companies around by paying a whopping 42%. Don't we wish we had fewer companies like F and more like E?!

Now about profit margin. Boy companies H and W sure have it rough – hard to eek out a living with a 3-4% bottom line margin delivered to shareholders. We need to find some ways to help them out. Perhaps more regulation so evil companies like A and F don't sock it to the consumer so much! Hey, let's take from A and F and give to H and W!! That would be "fair"!

Although it's not apparent, company G also had a rough time – for the first time in a few quarters they actually have a positive profit margin and are paying 34% in taxes! Good for them! An example for all struggling companies.

Hopefully you haven't peeked, but perhaps by now you have guessed – especially if you have had to prepare income statements.

Here are the answers. Click on the hyperlinked name to go to the respective latest quarter income statement if you think I'm making this up.

A is Apple, E is very evil Exxon Mobil, F is the darling of the renewable energy crowd, First Solar. G is that evil company that supposedly pays no taxes, General Electric. H supposedly epitomizes all that is wrong with healthcare, HCA. And finally W is that company that a lot of folks love to bash but has low prices so the less fortunate can afford more crap, Wal Mart. All billions except for First Solar, which is millions.

So let's recap. Based on how much taxes they pay to momma government and how much evil profit they stiff us for: First Solar is evil because they don't pay a lot of taxes but Exxon Mobil pays a whopping 42%. And we should take (uh… 'redistribute') from Apple and First Solar and give it to HCA and Wal Mart so the playing field is "level." And we should figure out how GE turned around and help other companies follow their model.

Sorry about the exploding heads. Welcome to the real world.

A couple other points. Profit is the manifestation of value, and as anyone in the lean world knows, profit is not based on cost. It is based on tangible and intangible aspects of the product that create value for the customer. Apple creates a lot of profit because its products have a lot of value… including the fact that they just plain work in a highly intuitive manner.

Similarly, evil or the lack thereof should not be based on profit, but on operating practices – respect for people, the environment, and innumerable other factors. Apple uses outsourced manufacturing that has an apparent habit of driving workers to suicide. Wal Mart sources a lot of products from similar factories. Evil? You could easily make that argument to me, even as much as I love Apple products.

First Solar apparently receives a boatload of tax breaks – although we seem to always be talking about the tax breaks the oil companies supposedly receive (most of which all companies receive). Evil? Or not? How do those tax breaks and subsidies compare to those the sugar industry and such receive – and what is the impact? Evil? Lots of people want to break up huge companies and prevent monopolies because they create a lack of choice and innovation… then those same people often want to consolidate services like healthcare into a single large government monopoly. Evil?

Finally, I thought about adding a column for the government itself – you know, the big negative margins thanks to dangerous deficit spending, a negative 100% tax rate since they suck it all out of us, etc. But I couldn't, at least not at the high standard of quality that Evolving Excellence readers demand. Why? Because the GAO has been unable to certify the financial statements of the government for many years.

GAO is responsible for auditing the financial statements included in the Financial Report, but we have been unable to express an opinion on them for the 10th year in a row because the federal government could not demonstrate the reliability of significant portions of the financial statements.

But go ahead and create more bandaid regulations like SarBox for the rest of the world.

I’m always befuddled by those that think of profits in pure dollar terms instead of percentages. Operating a company with thin margins like Exxon or Wal Mart takes enormous effort, with small changes creating huge changes in cash flows. Although as you and Bill often point out, Wal Mart’s “effort” is simply pounding on suppliers and chasing cheap labor. Anyone remember the days only a couple decades ago when Sears or Penneys were going to take over the world? Yep.

Exceptionally clarifying insights here, Kevin. Another post that gets booted to the top of the list. And to my friends.

What’s interesting to me: You strip down what is clearly warehouses full of accounting documents into a simple blog-post-ready table. There, you expose one of the greatest benefits of LEAN: Minimum Viable Product. Here it is. It’s like the Six Pack Abs of accounting.

The other point most pundits and common folk forget is that there has to be a buyer for every seller. For every evil seller of high priced oil, mistakenly valuated real estate, and the like, there is an equally evil or ignorant buyer. I suppose I can sympathize with individual buyers of real estate who didn’t read the fine print of their contracts, but I can’t excuse the buyers of high priced oil. In that case the value is the value. Deal with it.

To Diane’s point, most people don’t realize that there are very few companies that can operate in a <10% (if not <20%) margin environment. To do so you need a large total dollar cushion and opportunity. This is always the problem with the idea of breaking up a "huge" (by what measure?) company into smaller pieces because "it is too big." By breaking it into smaller companies each of those will need larger margins to operate safely therefore the overall cost of the supplied goods will go up. Is that what's desired?